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ECON7740 Cost Benefit Analysis

Tutorial 5 & 6

Question 1

Suppose the government is considering an increase in the toll on a certain stretch of highway from $.40 to $.50. At present, 50,000 cars per week use that highway stretch; after the toll is imposed, it is projected that only 45,000 cars per week will use the highway stretch.

a)   Assuming that the  marginal  cost of  highway  use  is constant  (i.e., the supply schedule  is horizontal) and equal to $.40 per car, what is the change in social surplus attributable to the increase in the toll? (Hint:  The toll increase will cause the supply schedule, not the demand schedule, to shift.)

b)   Because of the reduced use of the highway, demand in the secondary market for subway rides increases. Assuming that the  price  of  subway  rides  is  set  equal to the  marginal  cost  of operating the subway and marginal costs are constant (i.e., the supply schedule is horizontal), and no externalities result from the reduced use of the highway and the increased use of the subway, are there additional costs or benefits due to the increased demand for subway rides? Why or why not?

c)    Because of the reduced use of the highway, demand in the secondary market for gasoline falls

– indeed, by 20,000 gallons per year. There is a stiff tax on gasoline, one that existed prior to the new toll. Assuming that the marginal cost of producing gasoline is $1 per gallon, that these marginal costs are constant (i.e., the supply schedule is horizontal), that no externalities result from the consumption of gasoline, and that the gasoline tax adds 30 percent to the supply price, are there any additional costs or benefits due to this shift? If so, how large are they?

Question 2

Consider a low-wage labor market. Workers in this market are not presently covered by the minimum wage, but the government is considering implementing such  legislation.  If implemented, this law would require employers in the market to pay workers a $5 hourly wage. Suppose all workers in the market are equally productive, the current market clearing wage rate is $4 per hour, and that at this market clearing wage there are 600 employed workers. Further suppose that under the minimum wage  legislation, only 500 workers would  be employed and 300 workers would  be  unemployed. Finally, assume that the market demand and supply curves are linear and that the market reservation

wage, the lowest wage at which any worker in the market would be willing to work, is $2.                   Compute the dollar value of the impact of the policy on employers, workers, and society as a whole.

Question 3

Complete Case Study – Market and Private Perspectives.